Taking advantage of all the right deductions in order to reduce your taxable income, or the amount of your income that is taxed, and all the right credits in order to reduce the total amount of taxes you owe, is called tax planning. Tax planning can save you money at tax time. To pay less in taxes, follow these tax-planning steps:

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Steps

1

Reduce your taxable income. This will result in a reduction in your taxes. Some ways of reducing your taxable income for the year include:

Saving for retirement. Contribute pre-tax funds to a 401(k) retirement account before December 31 and/or to an IRA before April 15 to lower your taxable income.

Opening a Flexible Spending Account aka F.S.A. An F.S.A. allows you to contribute pre-tax dollars to an account you can use to pay for qualified health care expenses, such as co-pays and expenses outside of your health insurance plan.

Purchasing a tax-deferred annuity. A tax-deferred annuity is similar to a retirement savings account. It is purchased with pre-tax dollars, which earn interest without income taxes being due until you begin receiving payments from the annuity. Once you begin receiving payments from the annuity, income taxes are due only on the actual amounts you receive.

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2

Become familiar with the various tax deductions. A tax deduction is subtracted from your gross income, thereby reducing the amount of income on which you will be taxed, or your taxable income. To learn what deductions are available see the Internal Revenue Service form 1040 Instructions at http://www.irs.gov/pub/irs-pdf/i1040.pdf. When you know what tax deductions are available, you can ensure that you take them and take advantage of them. Some ways to take advantage of various tax deductions include:

Calculating your itemized deduction. You may choose to either itemize your deductions or take the standard deduction for your filing status. Many taxpayers simply take the standard deduction without ever calculating the itemized deduction. Calculating the itemized deduction each year will ensure that you taking the larger amount.

Reporting your charitable contributions. Many taxpayers fail to report non-cash donations to charitable organizations such as Goodwill and the Salvation Army. Get a receipt, estimate the value of the property you donated, and report it.

Going back to college. Interest on student loans and tuition and fees may be deductible if you attended a qualified educational institution and had a modified adjusted gross income of less than $70,000.

Opening a Health Savings Account aka HSA Distributions from an HSA used exclusively to pay for qualified medical expenses may be deducted from a taxpayer’s gross income.

3

Do not overlook tax credits. A tax credit is added to the total amount of payments you have made throughout the year, and therefore reduces your tax bill in an amount equal to the credit. For example, if the federal tax withheld amount on your W-2 is $2,000 and you take a tax credit of $500; the total amount of taxes you are considered to have paid is the $2,000 you actually paid plus the $500 for which you receive ‘credit’, for a total of $2,500. Some examples of credits you may be overlooking:

Making Work Pay Credit. The Making Work Pay credit is available to those whose taxable income, is less than $95,000. Single filers take up to $400 and married filers up to $800 for this credit.

Earned Income Credit (“EIC”). Many taxpayers are aware of the EIC for those with children, but taxpayers earning less than a certain amount, $13,460 for single filers in 2010, who do not have children, may also take the EIC.

Credit for child and dependent care expenses. You may be able to claim a credit for expenses you incurred for childcare for children under the age of 13 and care for certain disabled persons who lived with you for more than half the year.

4

Convert your Traditional IRA to a Roth IRA. If you have a Traditional IRA, it may be best to convert it to a Roth IRA. You will owe income tax on the entire amount converted, but all the earnings on that money will be tax-free later when you withdraw it. This may make the most sense for young workers who plan to be earning more income, and therefore be in a higher tax bracket later.

5

Incorporate your business. If you own an unregistered sole proprietor business, you may want to consider forming some type of legal entity such as an LLC or S Corporation, as this may give you a greater tax advantage in the form of more available deductions and credits.

6

Use tax shelters. A tax shelter is a tax ‘loophole’ created by Congress to help reduce or eliminate a taxpayer’s taxes by allowing him or her to offset income from one source with losses or deductions from another. Common shelters include real estate, oil and gas, and Roth IRA accounts. For complete information on tax shelters, consult a Certified Public Accountant (“CPA”) or investment advisor.

7

Hire a professional. Tax preparation software has made leaps and bounds in its ability to find all the credits and deductions to which a taxpayer is entitled, and large tax preparation companies such as H&R Block are convenient and perfectly qualified to prepare income tax returns. However, nothing beats a CPA or Internal Revenue Service enrolled agent for tax expertise that will save you money.

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Warnings

The IRS does not allow tax shelters, which it considers abusive. Shelters that offer inflated tax savings, exist primarily to reduce taxes unreasonably, or is marketed in terms of how much you can write off in relation to how much you can invest may be abusive. See the IRS’s website at http://www.irs.gov/faqs/faq/0,,id=199691,00.html for more information on abusive tax shelters.